Failure to Enact Bigger Stimulus Was a Fatal Mistake

As expected, the Democrats took big losses in the midterm Congressional elections on Tuesday, holding on to the Senate but losing the House. It is typical for the party of the President to lose some seats in midterm elections, and it is doubtful that this election result represents the beginning of another conservative era. But the Democrats’ losses were big by any measure.

The overwhelming reason for the Democrats’ losses was their failure to take the necessary measures to ensure a robust recovery from the recession.

This is a case where it clearly would have been better to fight for something that you want, and lose, than fight for what you don’t want, and win. Had the Democrats fought for a stimulus large enough to move unemployment to more normal levels over two years – and lost the battle in Congress – they would at least have a case that they tried and were stymied by the Republicans.

Of course, the Republican mantra that the American Reinvestment and Recovery Act of 2009 act didn’t do anything but pile up debt is sheer nonsense. The non-partisan Congressional Budget Office has estimated that between 1.4 and 3.3 million more people were employed by mid-2010, because of the stimulus.

But it was not enough. As my colleague Dean Baker has pointed out, the federal stimulus – after subtracting the state and local government budget tightening – amounted to about one-eighth of the private demand that our economy lost from the bursting of the real estate bubble.

The economy is always an important issue in national elections, but seldom more important than it is today – with 9.6 percent unemployment, millions more underemployed or dropped out of the labor force, and millions of Americans losing their homes. But our politics today – year round, not only during election season -- is based primarily on manipulating voters through media and advertising, rather than trying to explain even a minimal amount of substance to them.

The Democrats would have done better by telling the truth from the beginning: not only that they inherited this mess but explaining that it would take a huge amount of government spending to restore full employment. Enough to make up for the private spending that was lost. And that the alternative was – well, we are looking at it. This is not rocket science.

The irony is that our economy remains in a situation where we could spend this money without even adding to the public debt burden. This may seem like magic but it is not. When the economy is this depressed, with high unemployment and unused capacity, the Federal Reserve can create money and loan it to the Treasury – and such money creation does not cause any problem of inflation. In fact, since 2007, the Fed has created more than $1.4 trillion and used it to buy mostly mortgage-backed securities from Fannie Mae and Freddie Mac. But inflation is still running at just 1.1 percent annually – a level that is too low, even for the Fed.

Now the Fed is talking about creating more money and using it to buy long-term Treasury bonds. Since the interest on these bonds will return to the treasury, there is no cost to the taxpayer. This money creation can be – and could have been – used to finance enough job creation so that there would be no question about our economic recovery.

By failing to stimulate economic recovery, the Democrats gave Republicans a populist card on a platter, which the Republicans played, with pitchforks held high and torches blazing. With unemployment and economic insecurity generating mass anger, the Republicans paid little price even for extremist excesses. In this election, the Democrats’ one big mistake on the economy outweighs any others.